U.S. Credit Rating: No Risk Of A Debt Default?

Includes: GLD, SLV
by: Shaun Connell

One of the basic responses to those who are worried about a debt default by the US government is the notion that the US doesn't face that risk because the government has the power of the printing press in an age of fiat currency.

The argument goes that "sovereign debt defaults" are simply for governments not in complete control over their own currency creation, like the Greeks, the Germans, or the US under the gold standard.

This makes many feel quite good about the national debt, and helps create the appealing narrative that debt worries are mostly overblown.

But they're not. The national debt problem is slowly being built into a crisis which will eventually be structurally impossible to fix without massive economic upheaval, and "we print our own money" won't magically fix it.

Yes, The US Has A Default Risk

The US has a default risk, and the notion that we don't is silly. The anti-riskers generally claim that we don't have to default on our debt, so we don't have a default risk. But here's the problem: inevitability and risk aren't remotely the same concept, and conflating the two is a great way to set oneself up for a flawed approach to our national debt in general.

People who have made this claim range from proponents of Modern Monetary Theory (I won't lie, I love a lot of stuff from this camp, because they "get" things most other schools don't) to Warren Buffett himself. But it's still fundamentally untrue.

Just because we don't have to default on the debt doesn't mean the risk isn't there. And eventually, if it becomes increasingly clear that the US won't be able to use traditional means to pay debt payments, we'll begin having a very real discussion about what we'll need to do to in response. There are essentially two options:

Inflationary "default". This doesn't count according to rating agencies, at least, because it's not the "default" they're considering when placing ratings. If you print a bunch of money and create inflation, to the rating agencies, you're not defaulting because you're still paying your nominal payments.

Not everyone thinks this is a sound system, and rightly criticize it. Charles A.E. Goodhart is a professor of finance at the London School of Economics, and he explains:

Credit ratings do exactly what is claimed on the tin - they measure the risk of default. Indeed credit-rating agencies have done conspicuously well in the recent sovereign debt crisis, downgrading Greece before the market caught on and speaking truth to power. But such ratings do not, and have never claimed to, measure the probable loss of real value from holding nominal government bonds owing to inflation.

So technically, this isn't a default. But it does have economic consequences, which will lead to people asking whether we should use inflation or have a more traditional default.

Remember, our politicians aren't motivated by some sort of platonic "economic truth" philosophy. They're generally uninformed, populist, emotional, and completely clueless about how close they constantly push civilization to the edge of an abyss. Still, they do it. Want proof? Just look at the debt ceiling stalemate a year or so back. That's where the default risk lies.

This means that part of the default risk is the willingness of the debtor to pay the debt. And that willingness will get more and more up in the air as the US economy begins to face more problems stemming from debt. People will begin demonizing the debtors and "China" for owning the debt -- meaning that a defaults chances really are increasing.

Does the US have to default? Of course not. They have a printing press. But is the risk getting higher? Of course it is. And our credit rating will continue to reflect this.

What This Means For Investors

This isn't just an exercise in semantics. Understanding the risk of default is incredibly important for investors to be prepared for. The US economic system is completely unsustainable, and our deficits will likely keep growing in the future as entitlements continue to expand, healthcare costs grow, the college bubble gets worse, and the military empire is continually used.

The solution is to have long-term safe haven assets like gold, silver, and farmland in one's portfolio. This is the simplest reason I own gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV), and grow my portfolio in ounces every month and will do so regardless of the short-term news or elections.

When it comes to long-term economic survival, we have to ignore the short-term noise and look at the long-term trends people are trying to ignore, whether that's defaulting on the debt or peak oil becoming a problem.

Disclosure: I own physical gold and silver and buy more regularly. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.